Euro exit will not be enough for Greece

An editorial article in BloombergView (July 15, 2015) – Leaving Euro Is Better Than Eternal Greek Crisis – argued, with providing evidence, that “it would be better for Europe’s economic policy makers to spend their time figuring out how to manage an orderly Greek exit than continuing to negotiate deal after sure-to-fail deal to keep Greece in the euro”. Regular readers will know that I support an orderly breakup of the entire monetary union and if that is not possible then individual nations should exit on their own accord and reestablish some sane proportion in their macroeconomic policy settings. But exit is not a sufficient condition for restoring prosperity to a nation. They would also have to simultaneously abandon the neo-liberal Groupthink that holds the Eurozone economy in a vice-like grip of austerity. Under those provisos, the Greek economy would return to growth immediately and they could eliminate unemployment within a few quarters.

The latest data from Eurostat (July 14, 2015) – Industrial production down by 0.4% in euro area – tells an ugly story.

Industrial production fell by 6.9 per cent in Ireland in May 2015 (third consecutive month), by 5.1 per cent in Greece, by 2.1 per cent in Latvia, by 5.7 per cent in the Netherlands (third consecutive month), and by 0.8 per cent in Finland (falls in 5 of the last 6 months and zero growth in the remaining month).

Since the Euro was introduced, industrial production in Greece has slumped by 32.9 per cent, Spain 19.1 per cent, France 10.9 per cent, Italy 19.2 per cent, Cyprus 22 per cent, Malta 4 per cent, Portugal 15.6 per cent, and several nations such as Finland, the Netherlands have not expanded their industrial production at all.

The industrial base of some of Europe’s biggest economies has shrunk significantly and alarmingly in the peripheral Eurozone nations.

In the case of the Netherlands industrial production levels have fallen to those at the worst part of the GFC. The situation in Finland is worse than that.

In nations such as Greece and Spain, for example, youth unemployment has been at elevated levels since 2009, which meanst that in many cases significant numbers of young people will be entering the above 24 years cohort having never had a job. They will never has the chance to develop specific productivity skills or work experience.

The evidence suggests that they will take this disadvantage into their adult lives and cycle in and out of unemployment with some periods of low wage employment in between. They will never enjoy the advantages of previous generations which gained from the full employment policies that existed in the pre-neo-liberal era.

I cannot find a single piece of evidence that wouldd support the claims that the Eurozone had been a success. Even the price stability claims that the central bank continually makes are dubious given they are fighting the very real prospect of deflation and collapsing nominal asset prices (to follow on from the massive real estate losses that have already been endured).

I read an article today – The Effects of a Euro Exit on Growth, Employment, and Wages – published as Working Paper No. 840 (July 2015) from the Levy Economics Institute in the US. It was written by two Italians, an academic and a doctoral student.

It purports to make a case that a nation can prosper while remaining within the Eurozone and that an exit might be disastrous.

It opens with the statement:

A technical analysis shows that the doomsayers who support the euro at all costs and those who naively theorize that a single currency is the root of all evil are both wrong.

The technical analysis is low-tech to say the least.

But its overall observation that “If the economic policies of austerity imposed by the treaties stay in place, it is only a matter of time before another eurozone crisis occurs” is, in my view correct.

One doesn’t need ‘technical analysis’ of any great sophistication to conclude that. The monetary union was set up to fail even though the blind neo-liberal ideologues claimed virtue for the curious design they imposed on the people of Europe.

So irrespective of the exit issue, the Eurozone has to change and abandon its austerity bias if it is to survive.

As I argued in my current book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015) – the scale of the changes required to put the Eurozone onto a path to sustained prosperity would appear to be beyond the capacity of the political classes to implement.

They are so blinded by the neo-liberal Groupthink that they reject evidence that indicates they are overseeing a disaster and promote arguments that have no basis in reality and just make the situation worse.

The bailout proposal (if we are calling it that) presented to the Greek government at the weekend is irrational even if one evaluates it from the point of view of those who have no particular care for the Greek people but just want their money back.

This will just be another interregnum before the next (and larger) Greek crisis hits. And while we wait for that to happen, the material standard of living of the Greek people themselves plunges further.

Sure enough, the Greeks enjoy per capita incomes greater than Romania or Bulgaria. But since when are satisfied in using rockbottom as the benchmark measuring stick for whether a people have legitimate grievances or not?

The Levy article then attempts to evaluate “what the consequences of an exit from the euro might be”. They recognise that it is difficult to be definitive because it all depends on how the exit is achieved – group, orderly, agreed, single country, etc.

In considering an abandonment of the euro and a restoration of currency sovereignty, there would be a difference between what we might term an orderly, planned dismantling of the currency union while reinforcing the political union through the European Parliament, on the one hand; and a disorderly exit by one or a few nations (for example, Greece or Italy), on the other hand.

The obvious solution for one nation is not necessarily the best solution for all. I argued in my book that an orderly exit would be in the best interests of all nations even though there would be significant costs involved in making the adjustment back to full currency sovereignty.

But, given the political situation in Europe, it is more likely that a single nation would have to make a disorderly exit to get free of the euro.

Further, I believe the exit by a single nation would have relatively minor consequences for the remaining nations but enhance the prospects for recovery of the exiting country, notwithstanding rather massive adjustment costs. However, the larger the current malaise, the lower would be the relative costs of exit.

Greece is at the point where the costs of adjustment will certainly be below the cumulative costs of on-going austerity.

The Levy paper chooses to highlight the exchange rate effects that would accompany an exit. It says:

… the foundations of economic theory teach us that a country leaving the euro and returning to its original currency, with an initial one-to-one exchange rate, will immediately encounter a loss of value for the re-instituted currency, which will then become cheaper than the other currencies. This should favor the country’s exports and restrict its imports, improving the commercial balance, driving growth and promoting employment.

But economic theory does not handle the case of a nation returning to its original currency which is no longer in circulation. It analyses situations where a nation breaks a fixed exchange rate arrangement or a peg or abandons a currency board.

But the situation of a nation inventing a new currency is not the same as these other more common happenings.

In that sense, it is less clear that the path of the new currency is certain – that is, a substantial depreciation.

A currency’s value is determined by supply and demand in the foreign exchange markets, which, in turn, reflect trade flows (exports promote a demand for a currency while imports necessitate supply) and financial flows (inflows promote demand while outflow lead to a supply of the currency).

From day 1, the new currency would be in short supply especially as the national government enforces all tax obligations to be paid in that currency.

It would not currently exist in central bank reserves around the world nor in non-government portfolios.

So the conventional case of a currency that is already circulating fully in international foreign exchange markets etc coming off a peg and then floating only to see it sold off does not apply to a newly introduced currency in, initial, short supply.

This raises questions for the Levy authors’ analytical technique, which is to examine what happened to various nations that abandoned “previous exchange systems”.

For example, they adduce evidence from Australia’s float in 1985 after that nation tried to stay on a peg against the US dollar long after the Bretton Woods system broke down in August 1971.

The Australian dollar was an already strongly traded currency at the time the peg was abandoned and our external deficit was already substantial – around 6 per cent of GDP in December 1985 – meaning there was already a downward pressure on the exchange rate any way.

The Levy authors thus bias the analysis immediately by including in their sample:

… currency crises that in recent history have entailed large devaluations of the exchange rate and that were accompanied by the abandoning of previous agreements or exchange systems.

They claim they want to stay “firmly within the field of scientific approaches” to avoid “the pitfalls associated with the opposing ideological extremes” but set the technical analysis up in a way that assumes, say Greece, would experience a currency crisis from day one involving a “large” devaluation.

But lets play along a bit to see what their argument is.

They essentially examine what happened in 28 nations which were in this category (“large devaluations – over 25% against the dollar – which involved abandoning previous exchange systems”) after the float.

They focus on the effects on competitiveness, economic growth, employment and real wages.

They conclude:

1. Large devaluations “trigger inflationary processes” which “can annul the positive effects of devaluation”. But in high income nations (such as those in the Eurozone) this impact is rather mild and the nations retained more than 50 per cent of the gain in international competitiveness as a result of the depreciation.

2. The experience of higher income nations is heteregenous – some had no inflationary impulse, while other larger effects.

3. For higher income nations, “the commercial balance improves considerably” (competitiveness) after the depreciation and in most cases immediately.

4. This gain in competitiveness, stimulated economic growth in most of the higher income nations.

5. They found that despite the rise in international competitiveness and economic growth, employment growth was not as strong. The decline in unemployment in the higher income nations was small and reflected “a more intense use of labor and industrial capital”.

6. In the higher income nations, the major negative effect is on real wages as a result of the higher import prices. This helps them explain the sluggish employment growth response – domestic demand tends to support labour intensive sectors and if real wages are not growing strongly then spending will be subdued.

7. They then conclude that a “euro exit is not a cure-all” even though “abandoning the eurozone” would “trigger renewed growth”.

8. They consider the best outcomes occur “where wages were somehow protected from inflation, the domestic demand might not lose much impetus and this could sustain growth and employment”. Where growth relies on exports along, the domestic sector will fall behind and employment growth will be weak.

All of which is reasonable enough.

The point I make in my book is that European politics and policy making is caught in two very powerful and destructive vices at present.

The first is the age-old Franco-German rivalry. A corollary to this rivalry is a disdain for the ‘Latinos’ who by geographic proximity cannot be ignored, much to the angst of those further north.

The second is the domination of free market economics, the Groupthink, which though empirically deficient and riddled with internal theoretical inconsistencies, still rules the academy and through its graduates, the policy making sphere.

How the economics profession has been able to convince the rest of us that by ‘counting angels on a pinhead’ and then not being able to correctly sum the angels they claim to see (their so-called ‘economic models’), they have anything to say about enhancing societal wellbeing, is a study in itself and constitutes one of the biggest frauds of the 20th century and beyond.

All the evidence from psychology and behavioural studies tell us that the mainstream economic assumptions about human motivation and decision making are devoid of reality.

I agree that exit is not sufficient for nations in the Eurozone.

The rise of Monetarism, which originated out of the academy in the US, created a ‘post national’ tension among the politicians, which cut across the old state based rivalry between the nations in Europe.

Whereas the early discussions about union placed the national state at the forefront, by the time Delors and his Committee met, the global capture by the financial elites of the policy process was well entrenched and the promotion of Monetarist economic ideology aided their agenda.

Recall that Delors excluded the national finance ministers from his panel to ensure that the Monetarist perspective would emerge quickly and not become derailed by national political hankering.

It was imperative that the supranational entities, which were created as part of the union, were consistent with this post national ideology.

That is why the fiscal role of the state was so restricted and the primacy of the depoliticised ECB elevated. The old national rivalries have persisted but their expression has become increasingly channelled by the free market narrative, which created the monster that is the EMU.

Neither of these vices will release their destructive grip on European affairs easily. The cultural and historical aspects of the Franco-German rivalry are permanent constraints on European progress. It is true that this ‘enmity’ evolved in the post World War II period.

The diplomacy is less chauvinistic and the prospect of another major European war is minimal. Some have even considered the relationship between the two great European nations to be one of ‘amitié franco-allemande’. But despite the handshakes at official meetings and smiles for the cameras, there is always a simmering clash of culture and the memory of World War II is still strong.

While the rivalry was intense and open under President de Gaulle, which held back European integration, later the rivalry was expressed from the French side as a desire to neutralise German power, and the only way to do that was to create a European state where France dominated.

From the German side, whether anyone wants to talk about it or not, a deep and silent shame gripped the nation as a result of its actions during the 1930s and 1940s.

The only source of national pride became Germany’s economic acumen, its technical and organisational skills and the discipline of its workers. The stereotype of the ‘clever German’ arose to replace that of the ‘ugly German’.

European integration became a way the German nation could win back some respect by demonstrating that it could be part of a peaceful Europe. Reunification accelerated that desire but accentuated the paranoia in the rest of Europe about the ‘German question’.

This rivalry and divergent ambitions and motivations dominated the path to monetary union over many decades. When finally Mitterand and Schmidt seemed to be working together, the motivations and cultural baggage remained as disparate as they had been when Monnet and Schuman first proposed the ‘European Project’.

These differences suggest that both of the large European nations would be better off pursuing their own economic destinies.

But they can only do that if they also free themselves from the vice-like grip of neo-liberal economics. The dominance of free market thinking has so perverted the European Project, that the failure of the economic plan is now endangering the beneficial political and legal aspects that have accompanied the formation of the European Union.

The true value of the European Project is in its capacity to deliver a rule of law throughout Europe and engender multilateral co-operation on matters such as immigration, climate change, human trafficking and global concerns that single nations cannot solve alone. Abandoning the euro would not undermine that sort of cooperation.

Conclusion

Greece, for example, would be destroyed if it exited and retained the neo-liberal austerity bias in its domestic policy.

It would have to not only exit and follow the known guidelines for introducing their new currency but also abandon the fiscal rules that they endured as members of the Eurozone.

They would have to abandon the focus on the fiscal outcome and instead see it as a response to movements in the real economy.

Whether the Levy analysis is applicable is highly questionable. I think their sample is not particularly relevant to a nation introducing a new currency from scratch.

I also think there would be very strong reasons for the rest of the Eurozone to ensure the new currency doesn’t crash given that I would advise the exiting government to redenominate all official liabilities in their new currency – a power that the accepted principle of Lex Monetae bestows on sovereign governments.

But even if there was real wage effects – and the reality is that a nation’s real wage measured against import purchasing capacity depends on the movements in import prices – the government could assist by introducing a national Job Guarantee to ensure that anyone who wanted to work could earn a respectable minimum wage and add to public production and community well-being.

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